DUAL DECISION PROCESSES: AN APPLICATION TO FINANCIAL MARKETS

The aim of this work is to reconcile a theoretical approach to behavioral economics with a more practical analysis, through the development of a code that attempts to explain the fundamental theory. Behavioral economics describes human behavior in the economic realm using models that move far away from the assumptions of neoclassical economics, which assume a perfectly rational individual. Decision-making, on the other hand, is the ability to evaluate and select from a set of different options, the one that can guarantee the best possible outcome. Indeed, the decision is not isolated, but consists of a series of actions that require the contribution of psychological, cognitive and emotional skills. Some of our daily decisions are easy and immediate, while others are difficult because they are decisions with which we have no experience and hence require appropriate skills and time. As anticipated, ordinary people do not conform to classical economic rationality because there are also problems related to memory, attention and emotions. Furthermore, they are often influenced from the outside factors: opinions, points of view and ways of acting. We are then satisfied with a good enough solution, more intuitive methods and mental shortcuts. Unfortunately, we are indeed often victims of systematic thinking errors. This prompts us to envisage something new: a mental division underlying our choices. In the first chapter, we will illustrate the mental partition and its specifics. In the second chapter, we will explore how this division is involved in the way we make decisions. Having said that, the purpose of this work is to connect these theoretical aspects with something financial. In the financial markets, we can identify a particular category of investors (different from the rationality of professionals), which fits us and answers to the description of the irrational and spontaneous part of our mind. Starting from chapter three, we will go into the details of the link between economic theory and finance. The model presented, will, thus, explain everything that is anticipated in the previous chapters, thanks to the support of the Matlab codes. Finally, a practical connection is presented: in chapter four, we will move from a purely theoretical model to two more realistic extensions of financial markets, still considering the irrational participants mentioned above. The key element, on which the analysis of the extensions and the final comparison with the basic model will be based, are the codes.